Renew
Energy Ltd. (REL) manufactures and sells directly to customers a special
long-lasting rechargeable battery for use in digital electronic equipment. Each
battery sold comes with a guarantee that REL will replace free of charge any
battery that is found to be defective within six months from the end of the
month in which the battery was sold. On June 30, 2011, the Estimated Liability
under Battery Warranties account had a balance of $45,000, but by December 31,
2011, this amount had been reduced to $5,000 by charges for batteries returned.
REL
has been in business for many years and has consistently experienced an 8%
return rate. However, effective October 1, 2011, because of a change in the
manufacturing process, the rate increased to 10%. Each battery is stamped with
a date at the time of sale so that REL has developed information on the likely
pattern of returns during the six-month period, starting with the month
following the sale. (Assume no batteries are returned in the month of sale.)
Month
% of Total Returns
Following
Sale Expected in the Month
1st 20%
2nd 30%
3rd 20%
4th 10%
5th 10%
6th 10%
100%
For
example, for January sales, 20% of the returns are expected in February, 30% in
March, and so on.
Sales
of these batteries for the second half of 2011 were:
Month Sales
Amount
July $1,800,000
August 1,650,000
September 2,050,000
October 1,425,000
November 1,000,000
December 900,000
REL’s
warranty also covers the payment of the freight cost on defective batteries
returned and on new batteries sent as replacements. This freight cost is 10% of
the sales price of the batteries returned. The manufacturing cost of a battery
is roughly 60% of its sales price, and the salvage value of the returned
batteries averages 14% of the sales price. Assume that REL follows IFRS and
that it uses the expense approach to account for warranties.
Instructions
(a)
Calculate the Battery Warranty Expense that will be reported for the July 1 to
December 31, 2011 period.
(b)
Calculate the amount of the provision that you would expect in the Estimated
Liability under Battery Warranties account as at December 31, 2011, based on
the above likely pattern of returns.
(a)
Calculation of the sales price of batteries expected to be returned:
|
July –
September sales X 8% return rate
|
|
|
($1,800,000 + $1,650,000 + $2,050,000) X 8%.......................
|
$440,000
|
|
October –
December sales X 10% return rate
|
|
|
($1,425,000 + $1,000,000 + $900,000) X 10%........................
|
332,500
|
|
See also
total in part (b)
|
$772,500
|
Estimated cost to replace batteries that have been returned as defective
(measured as the sales price of batteries to be returned X cost of sales
percentage):
The account balance in the “Battery Warranty Expense” account for the
period July 1 to December 31, 2011 is calculated as follows:
|
Estimated
cost of replacing batteries related to the July – December sales:
|
|
|
Cost to replace batteries ($772,500 X
60%)...........................
|
$463,500
|
|
Freight cost ($772,500 X 10%).................................................
|
77,250
|
|
Less: Salvage value ($772,500 X 14%)..................................
|
(108,150)
|
|
See also
total in part (b)
|
432,600
|
|
Less:
adjustment for the warranty liability not
|
|
|
needed from expense estimate for the
|
|
|
first half of the year....................................................................
|
(5,000)
|
|
Battery
warranty expense, July 1 – Dec. 31, 2011....................
|
$427,600
|
(b) The
amount of the provision required in the Estimated Liability Under Battery
Warranties account as at December 31, 2011 is calculated as follows:
|
Month
|
Sales
amount for month
|
% of
battery returns expected
|
Sales
price of batteries expect to be returned
|
Cost to
replace defective batteries (= 60% + 10% – 14% = 56% of sales returns)
|
% of
defective batteries remaining to be returned as at December 31, 2011
|
Provision
required (= cost to replace X % remaining to be returned)
|
|
July
|
$1,800,000
|
8%
|
$ 144,000
|
$ 80,640
|
10%
|
$ 8,064
|
|
August
|
1,650,000
|
8%
|
132,000
|
73,920
|
20%
|
14,784
|
|
September
|
2,050,000
|
8%
|
164,000
|
91,840
|
30%
|
27,552
|
|
October
|
1,425,000
|
10%
|
142,500
|
79,800
|
50%
|
39,900
|
|
November
|
1,000,000
|
10%
|
100,000
|
56,000
|
80%
|
44,800
|
|
December
|
900,000
|
10%
|
90,000
|
50,400
|
100%
|
50,400
|
|
|
|
|
$772,500
|
$432,600
|
|
$ 185,500
|
